Google Very Exposed to US Recession--Expert

A digital-ad industry insider thinks Google is far more exposed to a US recession than the market realizes. The insider also thinks that the next two quarters will be "rough."

The insider is not a Google employee, but s/he has real-time insight into digital ad spending and is therefore not just talking out of his/her posterior. The insider's view is based on two key assumptions:

A significant percentage of Google's customer base is exposed to economic weakness (logic below), and

As consumers spend less, the ROI for many Google advertisers will drop--and this will cause them to spend less on Google (We concur with this view, which is still a minority view.)

The insider's analysis is sophisticated, so we will walk through it in detail. It also relies on significant estimation and extrapolation: The insider does not have inside knowledge of Google's numbers. We find the insider's logic compelling, however--more so than Google's strange explanation for the Q4 miss, which we still don't think makes sense.

A SIGNIFICANT PERCENTAGE OF GOOGLE'S ADVERTISERS ARE EXPOSED TO WEAKNESS

The insider estimates that Google's customer base can be roughly segmented as follows:

Approximately 1.2 million total AdWords customers.

Approx. 800,000 active AdWords customers (the rest inactive because they have stopped using Google or because of seasonality).

Approx. 60% of AdWords revenue comes from customers who spend $200,000 or less per month.

Approx. 50% of AdWords customers spend $50,000 or less per month (Small and Medium-sized businesses).

Approx. 20% spend $10,000 or less per month (Small businesses).

The primary economic exposure, the insider believes, is in the 50% of customers that spend $50,000 or less per month. We don't know what percentage of Google's revenue these customers generate, but we would estimate a third or more. If customers who account or a third of Google's revenue decrease their spending by a third, Google's revenue growth would slow sharply.

A lot of these advertisers are the etailers, real-estate companies, financial-services companies and other small and medium-sized businesses that built Google in the early years. These companies are very exposed to economic weakness, the insider argues, and very sensitive to changes in ROI.

The insider works for a digital advertising company that has seen severe drops in spending at small- and medium-sized enterprises in the past few months (one client that had $4-$5 million in sales in the 2006 holiday season had only $1 million in sales this year). The insider believes that Google is seeing or will soon see similar drops in spending in the SMB segment.

PRECISE ROI MEASUREMENT DOES NOT MEAN GOOGLE IS IMMUNE

Many investors persist in believing that because ROIs on Google are so measurable, advertisers will maintain their Google spending until they have cut all other advertising spending to zero. This ignores the fact that, when Google searchers have less money to spend, the value per click-referral to an advertiser and/or the number of search clicks will drop. Why? Because....

A consumer who had $100 to spend before the recession and now has $50 to spend will either:

Click on fewer links (resulting in less Google revenue) OR

Click on the same number of links but spend less (resulting in a lower advertiser ROI).

The former will hit Google's revenue because there will be fewer paid clicks (revenue units)--which is exactly what happened last quarter. The latter will hit Google's revenue because the amount advertisers are willing to pay per click will drop (unit prices).

In other words, the ability to precisely measure ROI cuts both ways:
The moment the ROI drops, spending drops commensurately. The insider further points out that, because many
small and medium sized businesses buy Google advertising in real time
on credit cards, the effect is immediate. What once took a
few months or quarters to work through formal media plans and long-term
contracts now happens instantly.

BOTTOM LINE

The insider believes that 50% of Google's US customer base could see severe drops in spending over the next couple of quarters. This would have a material negative impact on Google's overall revenue growth. At the very least, it would also likely startle investors who are still used to seeing Google blow the doors off.

Long term, the insider thinks Google is "a monster." But the next couple of quarters, the insider thinks, will be rough.